RS

MEMBER DIARY

Putting the “U” In Bankruptcy

Originally posted on The Minority Report.While I oppose the current form of the GM bailout, bankruptcy is a risky proposition. It is not a panacea, and we need to recognize that.

There has been a lot of chatter recently about the possibility that GM could file for bankruptcy. Corporate bankruptcy is an enormously complicated subject, and each one is unique. But here is a thumbnail sketch on what happens. For purposes of this discussion, I will use the “royal you” :>)

The Filing

You file in federal court. In other words, you go to the government, the government does not come to you. Normally some top executives and hotshot lawyers submit the filing to the court. The petition includes a recap of events that caused the distressed circumstances, and how those circumstances are now so dire as to require the bankruptcy filing. In the famous Enron case, the executives flew up in the firm’s brand new Gulfstream executive jet. This raised a lot of eyebrows. (Are you listening GM?)

The Motions

Once in bankruptcy, all expenses must be approved by the judge. First day motions will seek approval to pay normal operating expenses – ongoing salaries, utilities, etc. Liabilities originating prior to the bankruptcy will be settled from the bankruptcy estate.

The Locusts

The bankruptcy process requires an army of lawyers, accountants and other professionals to sort out what these liabilities are and how they will get treated in the inevitable restructuring. Bankruptcy is EXPENSIVE. The senior attorneys will bill north of $500 per hour, and will require extensive support from junior lawyers and administrative personnel. United Airlines spent several hundred million dollars on its bankruptcy, and it is a smaller company than GM.

The DIP

Bankrupt corporations are pretty leveraged by the time they go into bankruptcy. However, an adequate cash reserve to sustain operations during the restructuring is essential. One way of securing it is debtor-in-possession financing. The corporation borrows against its remaining crown jewels – intellectual property rights, saleable assets, still viable divisions, etc.- to build a cash kitty that is hopefully large enough to last until the final reorganization is done.

I Love Thee Nots- Rejection in Bankruptcy

Leases often compose a big part of a corporation’s capital structure. Bankruptcy allows a company to go through its leases and simply reject the ones that it no longer deems essential to its future operation. You can drop expenses in a hurry by just walking away from equipment and real estate leases, especially the turkeys. And if you’re the lessor who owns one of the turkeys, this is a frightening prospect.

Let’s Make A Deal!

Bankruptcy is very hierarchical. Claims against the estate are grouped into categories, and each one has its own method of settlement. Some of the major categories are trade payables, rentals, secured bondholders, unsecured bondholders, preferred equity and common stock holders. Generally, the latter are toast. The secured bondholders can either take over the assets or work with the company to restructure the debt. The unsecured bondholders will try to angle for as big a settlement on their principal as possible – 40 cents on the dollar, NO, 50 cents on the dollar, NO, sixty cents on the dollar, do I hear 65??!! Investors and creditors form alliances and work through their own teams of lawyers and accountants.

The End GameIf the bankruptcy is successful (and not all are), the company will emerge with a new capital structure. It will be a smaller, downsized company. The prior stockholders have been wiped out, the debt has been restructured with more favorable terms, the unsecured creditors receive their settlement at x cents on the dollar. The company issues new stock, the new owners hopefully see a rapid exodus of the locusts once the company is no longer beholden to the court, and then everyone gets to see if the job was done right.

Bankruptcy Links

Pensionshttp://www.pbgc.com/this site has critical information if you have a pension with a bankrupt company.

A Prime Example- United Airlines-http://www.pd-ual.com/This one was one of the biggies. As the lead page suggests, it is very complicated. GM’s would make this one look simple. United spent over $300 million on bankruptcy fees.